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Even when a business is losing money, it's possible for shareholders to make money if they buy a good business at the right price. By way of example, S2 Resources (ASX:S2R) has seen its share price rise 120% over the last year, delighting many shareholders. But while the successes are well known, investors should not ignore the very many unprofitable companies that simply burn through all their cash and collapse.
Given its strong share price performance, we think it's worthwhile for S2 Resources shareholders to consider whether its cash burn is concerning. In this article, we define cash burn as its annual (negative) free cash flow, which is the amount of money a company spends each year to fund its growth. Let's start with an examination of the business' cash, relative to its cash burn.
Does S2 Resources Have A Long Cash Runway?
A company's cash runway is the amount of time it would take to burn through its cash reserves at its current cash burn rate. As at December 2020, S2 Resources had cash of AU$15m and no debt. Looking at the last year, the company burnt through AU$4.6m. So it had a cash runway of about 3.1 years from December 2020. A runway of this length affords the company the time and space it needs to develop the business. You can see how its cash balance has changed over time in the image below.
How Is S2 Resources' Cash Burn Changing Over Time?
S2 Resources didn't record any revenue over the last year, indicating that it's an early stage company still developing its business. Nonetheless, we can still examine its cash burn trajectory as part of our assessment of its cash burn situation. While it hardly paints a picture of imminent growth, the fact that it has reduced its cash burn by 26% over the last year suggests some degree of prudence. Admittedly, we're a bit cautious of S2 Resources due to its lack of significant operating revenues. So we'd generally prefer stocks from this list of stocks that have analysts forecasting growth.
How Hard Would It Be For S2 Resources To Raise More Cash For Growth?
Even though it has reduced its cash burn recently, shareholders should still consider how easy it would be for S2 Resources to raise more cash in the future. Issuing new shares, or taking on debt, are the most common ways for a listed company to raise more money for its business. One of the main advantages held by publicly listed companies is that they can sell shares to investors to raise cash and fund growth. By looking at a company's cash burn relative to its market capitalisation, we gain insight on how much shareholders would be diluted if the company needed to raise enough cash to cover another year's cash burn.
S2 Resources has a market capitalisation of AU$54m and burnt through AU$4.6m last year, which is 8.6% of the company's market value. Given that is a rather small percentage, it would probably be really easy for the company to fund another year's growth by issuing some new shares to investors, or even by taking out a loan.
How Risky Is S2 Resources' Cash Burn Situation?
As you can probably tell by now, we're not too worried about S2 Resources' cash burn. In particular, we think its cash runway stands out as evidence that the company is well on top of its spending. And even though its cash burn reduction wasn't quite as impressive, it was still a positive. Looking at all the measures in this article, together, we're not worried about its rate of cash burn; the company seems well on top of its medium-term spending needs. Readers need to have a sound understanding of business risks before investing in a stock, and we've spotted 3 warning signs for S2 Resources that potential shareholders should take into account before putting money into a stock.
Of course S2 Resources may not be the best stock to buy. So you may wish to see this free collection of companies boasting high return on equity, or this list of stocks that insiders are buying.
This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.
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